Overpayment of U.S. Taxes May Prohibit Claim of Foreign Tax Credit

“Taxpayers must ensure that they only pay the withholding rate per the treaty.”

In a recent tax case (Meyer — 2004 TCC 199), the Tax Court informal procedure concluded that the failure to use treaty protection precludes a Canadian resident from claiming the foreign tax credit. In this case, the Canadian resident taxpayer received pension income from the United States. Pursuant to the Canada-U.S. Treaty, the maximum U.S. tax rate on that pension income should have been 15%. Unfortunately, the taxpayer never claimed this treaty rate and instead paid a much higher amount.

The taxpayer claimed this higher amount as a foreign tax credit on his Canadian income tax return. The CRA disallowed the foreign tax credit stating that the Canada-U.S. Treaty limited the income tax liability at 15%. Anything paid in excess of that was a mistake by the taxpayer and that the taxpayer had “gifted to the United States treasury a fiscal advantage.” In other words, they stated that the Treaty limits the tax liability and if you want to pay more than that, then its is your problem and they have no requirement to give you a foreign tax credit for this excess tax.

The informal judgement by the Tax Court agreed with Canada Revenue Agency in that they did not have to allow foreign tax credit where a taxpayer fails to assert his or her treaty rights. The onus is being placed on the taxpayer to ensure that they don’t pay more than they should.

This is a good warning for all professionals in that they should be aware that excess taxes paid are not allowed as a foreign tax credit and to also make sure that their clients do not pay more than the treaty requires.

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Cadesky Tax